What Is Passive Investing?

If you’re upset because of the market’s volatility, why not consider passive investing; rather than outperform the market, keep up with it.

Oct. 11, 2021

Instead of trying to predict the stock market, this well-known investing technique makes a steady flow of trades throughout the year. Investors that practice passive investing duplicate the overall performance of financial indexes to meet, not beat, the market. Here are some fascinating facts regarding passive investing that you should be aware of if you’re exploring it as an option.

Who invented passive investing?

Passive investing has only been around since 1976, when John Bogle, then the CEO of The Vanguard Group, (NASDAQMUTFUND: VTSAX) introduced it. The exchange-traded fund (ETF) allowed retail investors to invest with minimum effort and cost. The firm grew over time, providing investors with enormous returns on their initial investments.

How does passive investing work?

Passive investing is a long-term buy-and-hold technique in which investors optimize profits by reducing purchasing and selling. It invests funds using market-weighted indexes and portfolios while avoiding many of the costs associated with more active investing methods.

It’s not like other investments, but the goal is to grow wealth over the long term. Investors buy a representative market index and then hold a diversified portfolio of assets based on a wide, market-weighted index, such as the S&P 500 (NYSEARCA: VOO), Russell 2000 (INDEXRUSSELL: RUT), or the Fidelity(r) ZERO Total Market Index Fund (MUTF: FZROX). 

Key features of passive investing

Buy and Hold strategy: When it comes to passive investing, whether you have long-term monetary goals or not, Buy and Hold is a critical strategy. It’s an attempt to maintain balance with the market competition rather than outperform it. Investors put their money into a well-diversified portfolio in the hopes of seeing positive returns over the long run.

Investment into the index: Investors that use passive investment strategies eliminate some of the risks associated with actively selling and buying shares in the stock market. When the market falls, new investors may become overexcited and panic sell their stocks, causing them to lose a significant amount of money. Since it puts money into an index rather than a particular stock, a passive investment helps to prevent this.

Advantages to passive investing

Low fees: Neither frequent trading nor transaction commissions are involved since passive funds monitor the index. Despite the fact that fund management fees are unavoidable, investors will pay relatively little of it.

Diversify investment plans: Diversification, by its very nature, reduces the risk involved. Investors may also use more focused index funds to further diversify their holdings within industries and stock funds based on the stocks they select.

Simplicity: Having an index or collection of indexes is significantly easier to understand than constant changes happening in stock investments which need continuous monitoring.

Disadvantages to passive investing

Moderate Gains: Less pain but less gain can be true in the case of passive investing. 

Mediocre record of success: The statistics reveal that few actively managed portfolios exceed passive benchmarks after expenses and taxes. Indeed, the success rate is very basic, i.e. you will not beat the market, you will only match it.

Investors who don’t have time due to a hectic schedule, aren’t in a hurry with gains, or just want something stable, or who have long-term goals, such as saving for retirement, are best suited for passive investing.

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